Surprising Tax Saving Expenses Eligible For R&D Credits

Wednesday, March 17, 2021

In pandemic times, every penny saved counts. Tax planning can reduce business taxes, but there are additional savings opportunities. When it comes to research and development tax credits, certain costs related to wages, supplies and contract research are eligible, and can save you $$$. Taxpayers often overlook processes and routine work that counts towards extra tax savings. Why?

  1. Because the list of what might be eligible is more extensive than most business owners realize, and
  2. The R&D Tax Credit is for businesses of all sizes, not just major corporations with research labs.

Activities related to applied sciences and other technical projects qualify for companies in numerous industries; there doesn’t have to be a groundbreaking invention or revolutionary technology, it can be as simple as products and processes that are improved. Some years ago the PATH Act not only made the R&D Tax Credit permanent, it modified the credit for the benefit of small and mid-size businesses and opened up its availability to startups. If your company does any of the following, your business may qualify for the R&D Tax Credit:

  • Develops or designs new products or processes
  • Enhances existing products or processes
  • Develops or improves upon existing prototypes and software

Since the credit may be claimed for both current and prior tax years, companies can benefit from documenting their R&D activities to ensure they are positioned to claim the credit in both situations. To claim the credit, the taxpayer must evaluate and document their research activities to establish the amount of qualified research expenses paid for each eligible research activity. While taxpayers may estimate some research expenses, but must have documentation for the estimates. Examples of such documentation includes:

  • Payroll records
  • General ledger expense detail
  • Project lists and budgets
  • Project process and notes
  • Third party agreements

These records combined with credible employee testimony can form the basis of a R&D Tax Credit claim. Remember the 4-part test the IRS uses to determine if a project qualifies:

  1. Technical Uncertainty
  2. Process of Experimentation
  3. Technical in Nature
  4. Qualified Purpose

Startups and small businesses may qualify for up to $1.25 million (or $250,000 each year for up to five years) of the federal R&D Tax Credit to offset the FICA portion of their annual payroll taxes. Ensure you are receiving the full value you are entitled to under relevant IRS guidelines and Treasury regulations. To be eligible, a company must:

  • Have less than $5 million in gross receipts for the credit year
  • Have no more than five years of gross receipts

Standard procedure for claiming an R&D tax credit is to complete the required documentation and submit form 6765 alongside your company’s original filing. Companies either forget, or are unaware of the need to include this form.

Generally, you have at least 3 years from the date you file your tax return to amend your return to correct any errors or include any missing items. Additionally, this 3 year period can be further extended if you incur net operating losses, make subsequent tax payments, or voluntarily extend the time to assess deficiencies. Innovative companies that claim the credit every year will realize the highest return on their investment. Even if unutilized in a given tax year, credits can be carried forward up to 20 years, and, in some cases, recorded as deferred tax assets on your balance sheet.

Don’t fail to claim R&D tax credits because you think day-to-day activities don’t qualify for this dollar-for-dollar reduction in income tax liability. Here are some qualifiers that might surprise you:

  1. Cloud computing server, platform and SaaS software application innovation costs may be qualified research expenses (QREs) eligible for federal and state R&D credits. Cloud-hosted development platforms and beta testing of pre-released software programs are included (operating platforms are not).
  2. If companies migrate their platform or legacy systems during a merger, the development efforts related to the move may qualify if moving workloads and tasks from one system to another involves design, process improvements, technical uncertainty and points of failure, the baseline criteria for federal research credits.
  3. Replacing an obsolete part or product with a new design, or changing a product to accommodate a new part currently available on the market. This would require design changes and taxpayers who can provide proof of concept, demonstrate how the innovation made the product better, and document the failure points, may be able to recoup expenses related to design and testing.
  4. Process Automation tools that improve efficiencies such as automated shelving, robotic arms and labeling systems, which improve workflows and manufacturing processes. The time invested in designing the type of robot (static or dynamic), how and where that robot is used, and the trial runs testing the product or process may be qualified expenses.
  5. Any product or process using machine learning and artificial intelligence to learn how to do something better, faster and more efficiently qualifies for research credits.

Reach Out To Us: Many companies are eligible for R&D tax credits, with an expansive list of activities qualifying for the credit. Although it’s too late to claim your 2019 research credit as a payroll tax offset, companies can amend their return to monetize it as an income tax credit – and can even consider performing a ‘look-back’ to capture up to 3 years of unclaimed tax credits. To find out more about R&D tax credits, or to discuss whether your business qualifies, contact us at 855-542-7537 or CPA@fuoco.com.